Why CO2 regulation will lead to lower electricity prices

An observation on the greenhouse gas policy debate: Excluding those who question whether we need a GHG policy at all, the debate is fundamentally one about where certainty is most important. Some think the most important thing is price certainty and argue for a tax. Others think the most important thing is emissions certainty and argue for a cap. Every lobbyist in Washington these days assures us that the most important thing is path certainty and argue for special diversions of resources to their pet cause.

What all agree on is that uncertainty is unacceptable. And so, not surprisingly, we get policies like Waxman-Markey that are neither a pure cap nor a pure tax nor a pure subsidy, but a bit of certainty scattered hither and thither. Sausage making at it’s finest.

But do we really have that much uncertainty? At least in the electric sector (which is, after all, responsible for over 42% of US CO2 emissions), we have a fairly high degree of certainty on two ponits: in the short term, we’ll shift from coal to gas. And in the long-term, power prices will fall.

Which is probably sufficiently heretical to demand explanation.

Near Term

So why can we be certain of a near term shift to gas? That’s fairly easy: because we don’t have any other choice.

The current US power mix is supplied by coal (49%), natural gas (22%) and nuclear (19%). Everything else is piddly. 6% hydro, 2% petroleum and 3% from all other renewables combined. Given the 24+ month timeline required to design, finance, build and commission any new power plant, the only near term response to GHG pricing is to shift the resource allocation amongst those generators that are already built. And while nuclear is a low-carbon power source, it can’t generate any harder than it already is. As noted here (see Fig 4), the nuclear fleet is currently running at a 90% capacity factor, and on historically trends, appears to have pretty well maxed out. Which means that short of building new nuclear plants – hardly a quick, near term solution – there’s no way to swap coal-fired electricity for nuclear.

The gas fleet, on the other hand, hardly runs at all. In 2006, the fleet had a 20% capacity factor. Roughly speaking, this means that any given plant was shut down for four days out of every five. Gas fleet capacity factor bounces a bit from year to year, but generally stays in the 20 – 30% range. Thus, if we immediately put a price on carbon that immediately applies to all generators (color me politically naive if you wish), the immediate impact would be to shut some coal plants off and run some gas plants a bit harder. It’s not a long-term solution, and its cost depends solely on the price spread between coal and natural gas. But as noted here, it does have the potential to quickly and massively lower the CO2 signature of the US electric sector.

Long Term

Now to the heretical part.

Let’s extend our gaze sufficiently far into the future that new capital has been deployed, facilitating the retirement of the old dirty stuff. What’s it likely to look like?

I’m not foolish enough to make technology-specific predictions. But I will go out on one very small limb: power plants deployed in response to GHG controls will be less GHG-intensive than the ones we build today. Wind, nuke, solar, CHP, biomass, geothermal… and probably lots of other things we haven’t thought of (not to mention lots of end-use conservation).

Here’s the unifying feature of all those technologies: they cost less to operate on the margin than the stuff we use today. That’s not to say they’re all cheaper. After all, many of the technologies we will deploy in response to GHG regulation are technologies that today are held back due to high capital costs (solar, nuclear, etc.) But once a power plant is installed, the decision to run it one more hour isn’t based on capital cost recovery, but on the marginal cost of production. If it costs me $2.50 to make one more widget and I can sell it for $2.51, I’ll make that widget regardless of how much the widget factory cost me. That, in a nutshell is why our nuclear fleet today runs all the time and the gas fleet doesn’t. Inclusive of capital recovery, the gas plants have lower all-in costs… but on the margin, the nuke plants make more sense to run.

This point is key, and too often overlooked. We assume that new, low-CO2 technologies are held back by economics – but forget that those economics include both capital and variable costs. And in the long-run, it is only the variable cost that matters. Shifting to low-CO2 power is therefore a shift to low variable cost power. Which in turn is a shift to low cost power.

I should emphasize that it may take a while to get to this point, as initial prices from high-cost construction have to be amortized. A comparison with nuclear in the 1970s is instructive, when huge cost overruns put upward pressure on prices until the political will was broken and owners went bankrupt… but the plants kept running, and today form the low-cost base for much of our grid. This will happen again with new low-CO2 sources, for the simple reason that CO2 sources (e.g., fossil fuel) cost money. Cut the source, save the money.

I should also note that there is one exception to the low cost/low CO2 paradigm: Coal with CCS. It’s low CO2 (if it works) but high cost. Which is why it will never matter. It won’t be built unless subsidized, and if it is built, it won’t run. I’m certain.